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The Role of Regulation
Transparency strengthens market forces, theoretically reducing the need for regulatory enforcement. But the history of the past century shows that the transparency-driven surge of powerful market forces is not sufficient to change corporate behavior. As a matter of economic necessity, many firms may embrace norms of candor and integrity that exceed minimum legal requirements. But free riders will take advantage of the system as long as the legal umbrella protects them; and many, as we’ve seen, are quite willing to break the law.
Thus, free markets depend on strong governments. Public interests are greater than the sum of all private interests. And open market economies depend on clear rules, rigorously enforced.
Well-performing capital markets capture the wisdom of millions of investors, but this only works when investors have complete and accurate information on each firm’s financial health. This begins with trustworthy audited financial reports. External auditors were among the measures the U.S. government put in place after the 1929 stock market crash. But even then questions arose as to whether external accounting firms could be trusted. In 1933 a member of Congress asked Col. A. H. Carter, senior partner of Deloitte Haskins & Sells: who will audit the accountants? "Our conscience," Colonel Carter replied.(31) More than sixty-five years later, this premise sent Arthur Andersen up in smoke.
The protections in Sarbanes-Oxley are long overdue; if anything, they don’t go far enough. Some business groups fought even these mild measures. U.S. Chamber of Commerce president Thomas Donohue published a letter that accused Senator Paul Sarbanes of a "knee-jerk, politically charged reaction" to the Enron scandal and claimed that accounting reforms were a threat to "informed market decision-making." Not all groups were equally shortsighted. The Business Roundtable called for Sarbanes-Oxley’s swift implementation, saying the “legislation will help investors, employees and companies by restoring investor confidence.”
Rules also help a market economy by preventing unethical companies from externalizing costs onto other market participants. Example: the Prestige oil tanker sank off the Spanish coast November 2002, resulting in a human and economic disaster beyond that caused by the Exxon Valdez. The Prestige immediately disgorged 20,000 tons of fuel oil (half the amount spilled by the Valdez) and sank with another 60,000 tons still on board. Oil from the tanker contaminated beaches and shut down a $1.5 billion fishing industry that employed 120,000 people along the Spanish Galician coast. The oil then moved east to the Asturian and Cantabrian coasts. Oil stains were reported in the Basque province of Guipuzcoa. By early January 2003, cowpie-size globs began washing up on the shores of southwestern France, closing the area's famed oyster beds and tourist beaches. With a massive store of oil still in the sunken tanker, no one knows when this disaster will end.(32)
The Prestige was a regulatory basket case. It was, like the Valdez, a single-hulled tanker, a construction well known to create far greater risk of spill than a two-hulled ship; the U.S. banned single hulled tankers from its waters after the Valdez spill, but the European Union had failed to follow suit. The boat was chartered by the Swiss-based subsidiary of a Russian conglomerate registered in the Bahamas, owned by a Greek through Liberia, and given a certificate of seaworthiness by the U.S.. When the ship refueled, it stood off the port of Gibraltar to avoid the risk of inspection. Every aspect of its operations was calculated to avoid tax, ownership obligations and regulatory scrutiny.(33)
Such examples explain why societal expectations for improved corporate behavior result in pressures to regulate. The post-Enron environment has increased support for legislation in the U.S.: in July 2002, two thirds of Americans agreed that the free market economy works best when strongly regulated.
Government regulation can also create a level playing field for competition: many industries depend on patent laws to reward innovation and discourage free riders.
Regulation can itself be a double-edged sword. Disclosure rules could protect firms that externalize environmental costs. Business and social critic Amy Cortese notes: “With their confidence shaken in corporate bookkeeping and the market's omniscience, investors are starting to look for other possible ‘off balance sheet’ land mines, including the hidden risks that could be associated with global climate change…. (and) company officers could be held accountable for failing to protect their companies from climate-related risk.”(34) Rules for disclosing such risks could, by implicitly factoring them into the stock price, keep these shareholder lawsuits at bay.
But all this only proves that mandating disclosure is not enough; it may also be necessary to regulate behavior. Laws like the Environmental Protection Act don’t just expose – they restrict polluters’ behavior.
Regulation alone won’t produce open enterprises that always do the right thing. And legal compliance is merely the lowest common denominator. What really counts is leadership with integrity, beyond compliance.
Conclusion
A sea change is finally happening in corporate governance in the relationship between ownership and control. Shareholders are steadily acquiring the ability to scrutinize the ompanies whose share they hold, and the governmetn is helping to ensure that third-party overseers - auditors and regulatory agencies - are themselves held accountable. In short, the crisis helped to bring about an increase in transparency. Nevrtheless, after a century and a half of shareholder capitalism, the jury is still out on the theory that investor oversight can work.
Today's stakeholders expect a new kind of integrity. |
